Monthly Archives: November 2012

SEC’s Role in Enforcing the Federal Securities Laws

Wayne Carlin is a partner in the Litigation Department at Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell Lipton firm memorandum by Mr. Carlin, John F. Savarese, David A. Katz, David B. Anders, and Theodore A. Levine.

In a recent speech at the Securities Enforcement Forum, SEC Commissioner Luis Aguilar called for, among other things, increased enforcement activity against individuals, with more frequent use of Officer and Director bars, monitoring of recidivists through post-enforcement monitoring mechanisms such as access to phone and bank records and income tax returns, and passage of the SEC Penalties Act, which would allow the SEC to impose significantly harsher monetary penalties on individuals and institutions. We certainly understand the desire to rethink the SEC’s enforcement priorities, particularly in light of recent criticism of the agency. But we are concerned that this speech reflects an unwarranted blurring of the line that should separate the role of criminal prosecutors from that of the SEC.

The SEC is an independent regulatory agency whose mission has long been understood to be protecting investors and fashioning appropriate remedial action in the public interest — through deterrence of future wrongdoing and improvement of business conduct. When violations of the federal securities laws reflect willful conduct warranting punishment for wrongdoers, prosecutors should — and do — play the central role in seeking criminal prosecution. The SEC, by contrast, is not charged with enforcing criminal laws and its enforcement attorneys are not prosecutors.

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A Theory of Empty Voting and Hidden Ownership

The following post comes to us from Jordan M. Barry, Associate Professor of Law at the University of San Diego School of Law, John William Hatfield, Assistant Professor of Political Economy at the Stanford Graduate School of Business; and Scott Duke Kominers, Research Scholar at the Becker Friedman Institute for Research in Economics at the University of Chicago.

In our recent paper, On Derivatives Markets and Social Welfare: A Theory of Empty Voting and Hidden Ownership, we build and explore a formal theoretical framework to understand interactions between derivatives markets and shareholder voting behavior.

Ownership of stock in a corporation entails two types of rights with respect to that corporation. First, shareholders have economic ownership rights that entitle them to share in corporate profits. Second, they have certain legal rights of control over the corporation. These economic and control rights come bound together with each share of stock, but they can be separated, or decoupled. Decoupling can result in empty voting, in which an actor’s voting interest in a corporation is larger than her economic interest. It can also lead to hidden ownership, in which an actor’s economic interest in a corporation exceeds her voting interest. Decoupling raises a host of concerns because it turns the conventional logic for granting shareholders voting rights—their economic interest in the corporation—on its head. (See references here.)

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SEC Legal Bulletin on Shareholder Proposals

Richard J. Sandler is a partner at Davis Polk & Wardwell LLP and co-head of the firm’s global corporate governance group. This post is based on a Davis Polk client memorandum.

The SEC recently issued Staff Legal Bulletin No. 14G providing additional guidance on shareholder proposals submitted to companies pursuant to Rule 14a-8. The guidance is in response to several issues that came up during the 2012 proxy season.

Proof of ownership

In a prior bulletin, SLB No.14F, the SEC had reconsidered its view as to who constitutes a “record holder” for purposes of Rule 14a-8 and indicated that only DTC participants may provide adequate proof of ownership for shareholder proponents. Consistent with its no-action letter decisions during 2012, the Staff indicated in this bulletin that it would also view ownership letters from affiliates of DTC participants as satisfying the proof of ownership requirement.

Also, the Staff indicated that a shareholder who holds securities through a securities intermediary that is not a broker or a bank can satisfy Rule 14a-8’s documentation requirement by submitting a proof of ownership letter from that securities intermediary. If the securities intermediary is not a DTC participant or an affiliate of a DTC participant, then the shareholder will also need to obtain a proof of ownership letter from the DTC participant, or an affiliate of the DTC participant, that can verify the holdings of the securities intermediary.

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A Simple Tax Proposal to Improve Financial Stability

Ivo Welch is the J. Fred Weston Chair in Finance and Distinguished Professor of Finance at UCLA.

It is hard to imagine a financial crisis that is not ultimately caused by creditors who had taken on too much debt. Debt is the root cause of most corporate financial failures and, if a snowball effect sets in, the root cause of financial system failure. Of course, debt also has advantages. Without debt, many privately and socially valuable projects could never be undertaken. Still, it is our current tax system that has pushed our economy to be too levered. Now is the time to address the problem—before it will again be too late.

From a creditor’s perspective, the two key advantages of debt are the tax deductibility of interest payments and the ability of lenders to foreclose on non-performing borrowers (which makes it in their interest to extend credit to begin with). Although both factors contribute greatly to the incentives of the borrower to take on debt, there is one important difference between them: the tax deductibility of debt is not socially valuable.

To explain this issue, let’s abstract away from the beneficial real effects of debt and consider only the tax component. In an ideal world, taxes should not change the decisions of borrowers and lenders. They would take exactly the same projects and the same financing that they would take on in the absence of taxes. At first glance, one might argue that the tax distortions of leverage are not so bad, because the interest deductibility of the borrower is offset by the interest taxation of the lender. But this “wash argument” is wrong. It ignores the fact that capitalist markets are really good at allocating goods to their best use. In this case, it means that the economy will develop in ways that many lenders end up being in low tax brackets (such as pension funds or foreign holders) ,while many borrowers end up being in high tax brackets (such as high-income households or corporations). The end result will be not only that the aggregate tax income is negative, but that debt is taken on by borrowed primarily to reduce income taxes and not because debt has a socially productive value.

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